Romgaz, the recently privatized Romanian Natural gas producer looks like a pretty cheap play on the success of privatisation in Romania. Additional tail winds could come from the recently elected ethnic German President who wants to fight corruption and intends to repeat the business friendly and succesful model of his hometown Sibiu where he was mayor for 14 years.

Depending on the underlying value of the natural gas resources, the stock could have a potential upside between +50% in a pesimistic case and 200% in an otimistic one.

Disclosure & Risk: The stock presented is clearly risky and quite illiquid. The author might have bought shares before publishing this. Please do your own research !!!

On Romania

Romania is part of the European union, however it is the second poorest member, only trailed by neighbouring Bulgaria. The country never really recovered from the financial crisis and many Romanians left the country to work all over Europe.

Klaus Johannis became major in Sibiu, a mid size town in Romania in 2000 despite representing only 1% remaining ethnic Germans who live there since the 12th century. He was reelected 3 times and managed to attract a lot of German companies to his hometown Sibiu. As a consequence, Sibiu is the Romanian city with one of the lowest unemployment rates and the highest standards of living. By the way it is a really beautiful city very close to the Carpathian Mountains. In my opinion a very attractive yet undiscovered travel destination:

In Romania, the President has a lot more power and influence than for instance in Germany, I think one can compare it to France. Clearly, this election alone will no be enough, as for instance his opponent for the President’s job is still prime minister. nevertheless the vote should be a huge plus for Romania going forward, both as the new president seems to be trustworthy and anti-corruption as well a pro business and economy.

So how did the Romanian stock market react ? Ummm, if we look at the BET index, it didn’t react at all. Actually Romanian stocks are down since the election, so no “Modi Mania” for Romania it seems. One can speculate why this is the case, but in my opinion the Romanian Stock market is too small and so off-the-beaten-track that just no one bothered with it. And Romanians themselves do not really invest in stocks.

Romgaz

Why Romgaz ? Well that one is easy: This is the only Romanian stock you are able to invest if you don’t have access to the Bukarest Stock Exchange. There are no ETFs on Romania either.

Romgaz is a Natural Gas producer (“upstream”) with around 50% market share in Romania. Romania produces most of its own natural gas. In contrast to OMV-Petrom, its domestic rival, Romgaz only does “on shore” production,.

Romgaz has been IPOed one year ago and placed shares on the Bukarest stock exchange as well as on the LSE in the form of GDRs. Since then when the stock was sold at 30 Lei per share, not much happened with the stock price:

The great thing about a recent IPO is, that one usually gets the best information about the company and the sector through the IPO prospectus, which is normally much more comprehensive than any annual report.

+ no debt, significant net cash
+ only one share class
+ further scheduled price increases due to deregulation, mostly independent of market prices
+ many additional assets like gas storage (90% of total storage capacity), smaller distribution networks, power plant etc.
+ dividend payout ratio ~90%, resulting in a current dividend yield of ~8% (withholding tax “only” 16%)
+ High quality reporting (English)
+ privatised Government company with modern management -> lots of potential to be more efficient

– windfall tax applied in 2013 & 2014
– “royalty payments” on natural resources to Government which could increase (Nat gas & storage)
– “donations” to Government in the past
– government clients defaulted on receivables (that’s how they became owner of a power plant in 2013)
– government influence remains with 70% share
– proven reserves for only 10 years at current production rate
– reserve replacement rate very weak in the past (better in 2012/2013)

This is on the reserves from the IPO prospectus:

Owing predominantly to the re-evaluation of existing reserves, Romgaz has recorded an increasing replacement ratio, reaching 298% in 2012 (2011: 152%, 2010: 92%, 2009: 49%, 2008: 57%), with proved reserves being 71% of its total reserves. Romgaz believes that further increases of Romgaz’s reserves base can be achieved by improving its recovery rates through utilisation of well-established technologies. Romgaz’s size, longevity and market position has also helped it to enter into partnerships with major international natural gas companies including Lukoil, ExxonMobil and Schlumberger to develop other opportunities to increase reserves both inside Romania and internationally

On the upside, until 2012, Romgaz had to deliver their natural gas at “far below market” prices to their customers. Following the deregulation, prices can be adjusted to reach the market price in some years. Again from the prospectus:

Price Liberalisation
In addition, Romania has undertaken to fully liberalise the gas price for domestic production as well as the end-customer prices. In February 2013, the Romanian government started to implement a plan to deregulate natural gas prices by raising gas prices by 5% for non-household customers. It has planned to achieve the
complete price deregulation by 1 October 2014 for regulated customers and by 1 October 2018 for non-regulated customers. For non-household customers, the price of domestic gas is to increase from 49 RON/MWh, as of 1 February 2013 to 119 RON/MWh, by 1 October 2014, and for household customers, the price is to increase from 45.7 RON/MWh, in 31 December 2012 to 119 RON/MWh, by 1 October 2018.

Despite a windfall tax applied by the government, this development has been clearly positive for Romgaz with a 40% profit increase so far in 2014 against the prior year.

Valuation:

Valuing commodity producers by “standard” metrics like P/E or P/B often misses the point. The main value of a commodity producer is clealy “the stuff in the ground” minus the costs to get it out. However normally it is quite difficult to value the “stuff in the ground”. In the Romgaz case however we are again quite lucky. Part of the IPO information package was an independent “resources report” carried out by a large and well known US specialist company.

In this report, they calculate future “net revenue” including all costs taxes etc. and then come up with an NPV. In the Romgaz case, they actually created 3 scenarios: A base case, a low case and a high case. Addionally they provide NPVs for different discount rates, ranging from 8-15% p.a.

So in order to fully value Romgaz we can do a relatively simple asset-based valuation: Using the value of the reserves from the report plus any “extra assets” like the storage facilities and the power plant.

This is what I came up with for Romgaz:

Some comments:

– for the net cash I used the most recent quarterly report 09/2014
– I assumed a valuation of 6x EBITDA for the gas storage in all cases (one could argue for a much higher valuation as “infrastructure asset”)
– I assumed the original “purchase price” of the power plant form early 2013 as the market price
– for the “resources worst case”, I used the lowest value from the report (low case, only proven reserves, 15% discount)
– for the mid case I used base case, proved plus provable resources discounted at 12%

I think it is important to mention that this valuation does not give any credit to a potential exploration of new reserves, this is pure “run-off” only.

In any case, even in the worst case, the stock would have a 50% upside to “fair” value, although the fair value would still imply that you make ~15% p.a. after this value has been achieved. In the more optimistic cases, the current stock price seems to represent an even higher upside. Clearly, there is no guarantee that this value will be realized within a short time frame, but it clearly should limit the downside and create a relatively attractive risk/return relationship.

Why is the stock cheap ?

To me, this could be the combination of different factors, Mostly in my opinion:

– natural resource companies/commodities are out of favour anyway
– Emerging Markets and especially Eastern Europe are unpopular and Romania is even further away from the “Beaten track”
– there is no local shareholder base for Romanian stocks

A few words on Russian companies (Lukoil, Gazprom)

P/E wise, Russian natural resource companies look a lot cheaper and I expect some readers to comment that I should rather buy Gazprom at a P/E of 2 or so instead of Romgaz at 10. For me, despite the higher multiple, Romgaz looks more attractive to me because:

1. there is less uncertainty with regard to property right etc. in Romania. Despite obvious issues with corruption, Romania has proven that Democracy works and it is full member of the European union. This should significantly lower the risk of any “Sistema scenario”.
2. Due to the privatization story, Romgaz is less exposed in the next years to overall market price fluctuations.
3. Despite the low P/Es shown, you never know what actually happens with all those Russian profits. Dividend payout ratios are very low and the companies issue debt like crazy. Romgaz in comparison pays out a large amount of earnings and runs a big cash surplus

Summary:

In my opinion, Romgaz offers a compelling combination between a recently privatized company at a large discount to its underlying value and a potential “macro trigger” for Romania following the surprise election of an ethnic German as new President.

As Romania is so “off the beaten track” for stocks, it might take some time to realize this value, but in between one is paid quite handsomely with a 7-8% dividend yield.

As a result, I will enter into a 2,5% position as part of my “Emerging Markets” bucket at current prices (34 RON / 7,60 EUR per share).

Overall, I expect to make ~100% over a 3-5 year horizon. 30-40% should come through dividends, the rest with price appreciation, mostly based on increased earnings. Downside factors to watch are clearly any government interventions (additional taxes, royalties), further upside could be realized if reserve replacement ratios develop better than expected.

Keeping track of all the companies one has ever looked at is pretty hard. It is pretty easy to update the companies which are in the current portfolio, but in my case, I often forget about the companies which I have looked a couple of years ago but didn’t buy for one reason or another or sold them. One of the great things of blogging is that you can easily look at everything you have ever written. Especially in the current environment, where good value investing ideas are pretty hard to find, it might make sense to look back at companies one has researched sometimes ago and either sold or not bought. Maybe they have become interesting again ? For me it is a lot easier to update myself on a stock I have looked 3-4 years ago compared to looking (and digging) into a completely new stock.

So in this new series, I will look into stocks I have written about and either sold or rejected and try to find out if something has changed or if some lessons could be learned.

AS Creation

AS Creation was the first detailed stock analysis on the blog in December 2010 (in German). The company back then looked cheap: Single Digit P/E, historically a single digit p.a. grower, 30% market share in Germany and the potential upside of a Russian JV (Russia was supposed to be a growth market back then). After some quite significant ups and downs, the stock was sold in August 2013 because the margins didn’t mean revert and the Russian JV was already in some trouble under “non crisis” conditions.

Looking back, the decision to sell in June 2013 at ~34 EUR looks smart if we consider the chart although in between the stock went up to 40 EUR again:

Operationally, AS Creation was hit by several negative events: First, the bankruptcy of Praktiker impacted them in the German core business, secondly, their French subsidiaries suffered and finally, the Russian JV which had to suffer from delays has been clearly hit by by the current crisis. With regard to the German business I have the impression that they never really rebounded to their historical average, maybe they did profit from some kind of anticompetition arrangements, for which they were fined. An interesting detail: They were convicted to pay 10,5 mn EUR in 2014, but they seem to have appealed the decision. To my knowledge, no appeal was ever succesful.

In any case, I don’t think AS Creation is interesting at the current level of 30 EUR. At a 2014 P/E of 15-20 (before any extra write-offs on Russia) there seems to be quite some turn around fantasy being priced in.

From my side there were 2 important lessons:
1. Mean reversion on single stock basis is nit guaranteed
2. If you buy cheap enough, you don’t lose much if things go wrong.

Looking back, this clearly doesn’t look like the smartest decision I ever made. Back then, I sold Medtronic at a loss of around -19%. Since then, the stock showed a total return of 167% in EUR. One of the interesting things about Medtronic is that a lot of the performance came from multiple expansion.

When I sold the stock at around 32 USD, the stock was trading around 10 times trailing earnings (3,27 USD per share 2010). 4 years later, reported earnings 2013/2014 have been ~20% higher per share at 3,80 USD, but Medtronic is now trading at around 18,5 times trailing earnings.

What is even more interesting than that is the fact that in absolute terms, 2013/14 earnings are at exactly the same levels as 2010/2011. Profit margins are even lower than back then. What happened ? Well, as in many cases for US stocks, the company bought back shares aggressively. Still, both ROE and ROIC declined but shareholders don’t seem to bother.

So despite the big run up of the share price, I don’t think that selling the shares has been a mistake. From a fundamental view the company looks worse than back then, however investors seem to be so happy about buyback driven EPS gains that they are willing to pay a pretty high valuation for this.

You could have speculated on such an outcome but as a fundamental investor, this would not have been in line with my investment philosophy. And clearly, You cannot increase the value of the company forever just by reducing the share count.

Stand-alone I would argue that Medtronic is clearly overvalued, based on the stagnating profit and deteriorating profitability. However with the current Healthcare “merger mania” I would not want to short the stock either.

Netflix

I briefly considered to skip the whole Netflix episode but then decided against it. Looking back, this clearly shows that one can do stupid things and still make money….

The author analyzes 18 companies which were succesfull for a very long time and compares them to less succesful companies in order to find out what set them apart. The most important point seems to be that the company is a “visionary company”, meaning that the company has a clear mission which is not only earning as much money as possible but somthing in the way of “We want to make people happy” (Disney). Combined with “core values” and “really big goals”, this, according to the author is the secret sauce for a long term succesfull organization.

Looking at those 18 companies clearly shows that since the book was written, not all the companies were great successes for their shareholders. Citigroup, Ford, Motorola were clearly not performance stars, on the other hand, a couple of o the companies (AMEX, Wal-Mart, IBM) are long-term successes and core holding of our value investing Hero Warren Buffett.

Is the book relevant for investing and if yes how ?

I think the answer is clearly “YES” and those are the 3 major points in my opinion:

1. Many current CEOs have read this book (and many future CEOs will read it) and try to act accordingly

For instance the “3G story” of the Brazilians who now run Ambev, Heinz and Burger King seem to have clearly taken this book as blueprint for their strategy. “Dream Big”, core values such as meritocracy, honesty etc. were clearly inspired by this. Edit: And yes, Jim Collins has actually written the foreword to “dream Big” and he seems to have worked with “mastermind” Leman for a long time.

Interestingly, in the book it is clearly said that just writing down those statements is clearly not enough, you have to live them every day which is not easy to achieve. So just when you see something like this written on an annual report, you know that they have read the book but you cannot be sure if a company actually follows those vision and values.

2. A strong vision and core values compared with a good alignment of management and investors might result in great shareholder returns

Many critics use the failed companies of the book as a proof, that success is more depending on luck than on any vision and core values. I would argue that they are missing one point: In many of the failed cases, there happened a serious disconnect between shareholders and management. The most obvious case is Citigroup, which at least since the 2000s was run to the benefits of the employees rather than for all stakeholders. The same could be said of Ford, where the Ford family did not really exercise the owner’s influence as it would have been necessary.

I think it is not random, that especially the companies which were held for instance by Berkshire (Amex, Procter) or where the founder / founding family has a strong tie to the business (Wal-Mart) did well. Both, the influence of a significant investor or a founder with a large ownership can ensure that a visionary company can be also a big success for shareholders. It is clearly not a 100% “hit ratio” but I think the chances for long-term success are clearly above 50%.

For me, Google for instance is a fantastic “visionary company”, but in Google’s case I am not fully convinced that their goals are fully aligned with me as potential minority shareholder.

3. Non-visionary companies can be very good investments as well but it might be harder to sustain success in the long run

The prime example for a non-visionary company in my opinion is Berkshire Hathaway. Buffett’s target has always been to compound shareholder’s wealth. That the company did this for so long and so successful in my opinion is clearly the result of Warren’s and Charlie’s genius and their long and healthy lives. Interestingly, now close to the end of their careers, they seem to be on the “Vision” and “core value” track. At least that is how I interpret the rebranding of many subsidiaries as “Berkshire Energy” and Buffett’s speeches about Berkshire core values which at least to my knowledge were not so prominent years ago.

I think it has become clear to Buffett, that a conglomerate formed by two geniuses might be hard to sustain when those two are not around anymore.Additionally it will be interesting to see how the interests of a future Berkshire CEO who will not own half of the company, will be aligned with the shareholders.

Summary:

Despite having some lengths, I think the book is a good and relevant read for investors who want to look a little bit outside typical investment literature. Some people might say that the book is too old to be relevant, but I personally think that the content of the book is pretty timeless.

E.ON affirms 2014 forecast
11/12/14 | Posted in: Finance
Adjusted for portfolio and currency-translation effects, EDITDA above prior-year level
Renewables’ share of earnings rises to 17 percent
Economic net debt reduced by €1.2 billion
E.ON today reported nine-month earnings that were in line with its expectations. It therefore continues to anticipate full-year 2014 EBITDA of €8 to 8.6 billion and underlying net income of €1.5 to €1.9 billion. Nine-month EBITDA declined by seven percent year on year to €6.6 billion. The absence of earnings streams from divested companies and adverse currency-translation effects were the main factors. On a like-for-like basis—that is, adjusted for portfolio changes and currency-translation effects—E.ON’s EBITDA was above the prior-year level.

I would call this kind of disclosure “Level 1”: How the company wants to be seen

So with “adjustments” things look better than last year. However this time even a relatively “mainstream” German magazine remarked that the earnings disclosure of EON is relatively difficult to understand.

Level 2: P&L – Some kind of truth

In their quarterly report, EON has to use Accounting standards at some point. After 15 pages of useless “Management report” the first “real” accounting number shows up on page 16.

In fat type you can see the following:Net income 255 for YTD 2014, which is around 90% lower than 2014. Then in small print they show the following:

then lead to a total loss of 2,2 bn EUR or -1,1 EUR per share for E.ON’s shareholders for the first 9 months.

If we look at the stock price, we see that the positive “spin” only lasted for around 20 minutes before the stock price started to drop.

Why are they doing this ?

Well, this is pretty easy and straight forward: This allows the Management to award them nice bonuses independent of what the total result for the shareholder looks like.

Total comp in 2013 according to the annual report for management was 18,5 mn, thereof around 13 mn “bonus”. And this in a year where the were only able to generate a comprehensive income o ~600 mn EUR or 2% ROE.

EON’s target achievement is measured the following way according to the annual report:

As under the old plan, the metric used for the operating-
earnings target is EBITDA. The EBITDA target for a particular
financial year is the plan figure approved by the Supervisory
Board. If E.ON’s actual EBITDA is equal to the EBITDA target,
this constitutes 100 percent attainment. If it is 30 percentage
points or more below the target, this constitutes zero percent
achievement. If it is 30 percentage points or more above the
target, this constitutes 200 percent attainment. Linear inter-
polation is used to translate intermediate EBITDA figures
into percentage

For a capital-intensive business like a utility, EBITDA in absolute is pretty useless. However it is pretty easy to achieve or beat for Management. As a shareholder you can be sure that your interests are not aligned well with those of the management. In my opinion, that whole mess at EON has a lot to do with this pretty obvious “detachment” between management and shareholders and only to a smaller extent with German energy policy.

Finally some other stuff

The most interesting item in the whole Q3 report for me was the fact that Electrical Power generation was actually 50% better (EBITDA) than in 2013 and more than 100% better on EBIT basis. The biggest drop yoy actually came from the natural gas business.

Summary:

EON’s Q3 report for me is a prime example for a badly managed company. The disconnect between management incentives and shareholders leads to nonsense reporting, mostly in order to avoid the hard truth of losses to shareholders. For instance anyone who wondered why they bought crappy assets in Brazil and Turkey instead of paying back debt should understand that this actually increased the bonuses of management irrespective of FX losses, write-offs etc. As an investor, one should stay as far away as possible from such companies, no matter how cheap they are because at some point in the future they will “hit the brick wall”.

My initial strategy obviously didn’t work out. Now however I am wondering why I didn’t short Sky Deutschland instead before the offer expired. It seems to be clear now that the price didn’t move above 6,75 EUR during the offer period, because most people attach a fundamental value of less than 6,75 EUR to the shares. That would have been second level thinking, but I missed it.

I read somewhere that you should only sell a stock from a portfolio if you are ready to short it. That would have been the best approach here.

The mechanics of the current “listed transferable tender rights” are the following: The less people who want to actually sell there shares, the lower the price of the tender rights and the higher the share price. As for now, it seems that not so many people want to sell. I have to confess that I got nervous when the price of Rhoen dropped after I bought on the first day ex rights.

In the future, I think it makes sense to wait longer and see how these special situation plays out. I think I waisted some “intrinsic optionality” by taking the small profit much too early.

– some of the many acquisitions could lead to further write downs, especially if a new CEO comes in and goes for the “kitchen sink” approach
– especially the energy business has some structural problems
– fundamentally the company is cheap but not super cheap
– often, when the bad news start to hit, the really bad news only comes out later like for instance Royal Imtech, which was in a very similar business. I don’t think that we will see actual fraud issues at Bilfinger, but who knows ?

– new orders in Q3 were very weak (new orders in the first 6 months were very strong)
– management basically said that a “full” recovery can only be expected for 2017

Interestingly, the whole press release had a very negative tone, they make no attempt to strip out the one offs etc. etc. Maybe it is coincidence, but if I would want to talk the stock down in order to maybe buy the company cheaply, I would do it exactly that way…..

This is what I said in September:

Looking at the chart, this might not be unrealistic as the stock price is still in free fall and any “technical” support levels would be somewhere around 39 EUR per share if one would be into chart analysis. In any of those “falling knife” cases, patience is essential anyway.

Vossloh will therefore be “only” on my watch list with a limit of 42 EUR where I would start to buy if no adverse developments arise.

So we are now very close to my potential entry point. I will watch this as closely as Bilfinger. Both for Bilfinger and Vossloh, Iit will be interesting to see if there will be some year end tax loss selling.

In October, the portfolio lost -0,8%. Compared to my benchmark (Eurostoxx50 (25%), Eurostoxx small 200 (25%), DAX (30%),MDAX (20%)) at -1,7%, this is an outperformance of +0,9%. YTD the score is +4,2% for the portfolio against -1,2% for the benchmark.

Obviously, October was a relatively volatile month (more to that in the comment). However, in the worst days in mid October, the portfolio behaved as expected with a max. draw down of “only” 1/2 of the benchmark.

In my opinion, two important aspects have not been highlighted very often. First, I think the major achievement of this is to make all the different bank models comparable. In my opinion, this is a result which should not be underestimated. Everytime when some kind of international standard is released, all the local governments try to lobby as hard as they can for exceptions for their own players. The result then is basically a general standard with very few “teeth” and no one is able to compare the results. In this case, the ECB has been quite succesful to make the results comparable and even get the approval of all the regulators which I find is quite an achievement.

Additionally, for me it was quite surprising that some banks actually failed. I would have expected more like “ok, they failed based on 2013, but have restored their capital already” outcomes. So I was quite surprised that especially for some Italian banks, the situation became quite difficult (esp., BMPS and Banca Carige). In my opinion this indicates that the ECB will not be a “lame duck” regulator, which in the long run is good news for the Euro zone despite more short-term issues. Plus, as Draghi is alway accused of helping the “Club Med” countries, this outcome shows that this is not the case.

Overall, despite all the negative opinion about the Eurozone, my opinion this is a very important and constructive step to get the “financial plumbing” right within the Euro zone. If and when this leads to a revival is another question but personally I think that the public opinion is underestimating what is actually being achieved here.

The second but more personal stress test was clearly the sudden drop in equity markets in mid October. Especially for the US market, this was the biggest drop since 3 years or so. I guess for many investors this was quite “spooky” as there was no apparent reason. In my opinion, a potential reason for this kind of volatility is the fact that many people who are owning stocks now shouldn’t own stocks. Buying stocks because the dividend yield is higher than the yields on deposits sounds good at first, unless your shares suddenly drop 10% or more. Often such investors are called “weak hands” because they sell just because of a drop in the share. After the financial crisis, many “weak hands” stayed out of the market for quite some time but are now returning mostly because of the low-interest rates.

Normally I don’t give general investment advise, but here I make an exception. Two points of advise to investors:

1. Don’t buy stocks because of the dividend yield
2. Stress test yourself: If October made you nervous, or you can’t afford your stocks dropping 10%,20%,30% or more, then you maybe shouldn’t be in stocks at all

I have clearly no divine insight where the stock market will go in the future, however we should expect the ride to be quite bumpy.